Debt-forgiveness for less developed countries

Multinational Business Review, Spring 1994 by Garg, Ramesh C

The outlook for a satisfactory resolution of debt crisis remains bleak. The protracted debt crisis still overshadows the horizon of international financial markets. It has been causing political instability and macro-economic collapse of the economies of several less developed countries (LDCs). The debt crisis has resulted in inhibiting the transfer of capital and investments from developed countries to the debt-ridden countries. Ironically, financial resources are now being transferred in ever increasing magnitude from developing countries to developed countries. According to the United Nations statistics, the developing world as a whole transferred $39 billion to the rest of the world in 1990 alone [United Nations, 1991:249]. The debt crisis also poses a serious problems for the economies of successful Asian borrowers. At the same time, stocks of several money-center banks are under severe pressure and selling substantially below their book values due to their exposure to the LDC debt, particularly to the Latin American countries. Various proposals have emerged to find satisfactory resolution of the debt problem [Miller, 1988 and Garg, 1989], yet the progress to date in reducing the debt burden has been very slow. According to the World Bank's estimates, the outstanding debt of all developing countries amounted to $1.35 trillion at the end of 1991, which was unchanged from last year's total (Lachica, 1991). A significant portion of this debt is owed to private banks. A number of Latin American countries have instituted debt-equity swap programs which have made a small dent in the growth of external public debt for the Latin American and the Caribbean countries. For statistical purposes, the external public debt is defined as the debt incurred or guaranteed by government repayable to non-resident in foreign currency, with an original maturity of more than one year. In this paper, wherever the term "debt" is used, it refers only to the external public debt and does not include the private external debt. According to the World Bank statistics, the external public debt of all countries increased from $351 billion in 1980 to a peak of $983 billion in 1991 (see Exhibit 1). (Exhibit 1 omitted)

The purpose of this paper is to reexamine the issue of debt crisis with a view to provide a lasting solution, i.e., to examine the strategy of "debt-forgiveness" for heavily indebted Latin American and other developing countries. Thinking along the lines of "debt forgiveness" is neither radical nor entirely a new concept. In 1991, British Prime Minister John Majors announced to unilaterally push through a plan to slash the debt of the world's poorest countries (Carrington, 1991). Under this initiative, Britain and any other lender nations that go along with it, would write off two-thirds of the debt owed by 20 nations categorized as the world's poorest. For Britain, that means forgiving about $830 million of $1.3 billion lent to the cash-strapped countries.

Brazil, the world's largest debtor nation, announced in 1988 that it was going to suspend interest payments on its $67 billion commercial debts. This announcement sent shock waves throughout banking board rooms across the United States and Europe. Many of the private international banks rushed to follow the lead of Citibank, which announced an addition of $3 billion to its loan loss reserves against its $14 billion in LDC debt. Yet, lender banks and creditors have been carrying LDC debts at their book values. It has been taken for granted that the debtor countries would continue to honor debts at their full book values. In the secondary markets, however, the debts of some major borrowing countries are changing hands for as low as 20 cents on the dollar with very few buyers in sight (see Exhibit 2). (Exhibit 2 omitted) An increasing number of international bankers are reconciling themselves to the idea that a substantial portion of less-developed country debts will simply have to be forgiven. Bank analysts believe that virtually every debt rescheduling plan offered in the future will contain some element of debt forgiveness (Andrews, 1988).

DEBT CRISIS OF THE 1980s

Mexico's announcement in August 1982 that it could no longer service its international financial obligations signaled that start of the 1980s debt crisis and set the stage for a rash of debt rescheduling. Proposals to reduce the size of outstanding debt were emphasized during the early stages of the post-1982 debt crisis, but did not get any support from either the various lending governments of developed countries or the major private bankers. Even the International Monetary Fund (IMF) made its financial support for the debtor countries contingent upon their accepting an 'austerity plan" and to continue servicing their debts. Countries that continue to accumulate arrears in their foreign debts were made ineligible to receive the IMF's so called, "helping hand." This policy greatly increased the private banks' bargaining power in dealing with debtor countries. As the debt talks dragged on, banks became increasingly reluctant to lend new money. In the early stages of negotiations, private banks had been persuaded to offer new money in exchange for the debtors' efforts to keep up with debt service payments, but gradually this bargain looked less appealing to the private bankers. Towards the end of the decade, deals including new money became extremely rare. As a result, the accusation that the IMF was acting as a debt collector for the private bank began to sting (Anonymous, 1991).